Thread by @docbaty

OK, so let’s take a quick look at today’s CPI figures, and they’re not great numbers. But first, some context around the CPI, why it's of interest, and what today's numbers mean (and don't mean but will try to be blamed on anyway)...

1. Let's start with some context. CPI - Consumer Price Index - is an economic measure that gives us some sense for how quickly prices are going up. The ABS looks at a 'basket' of standard household goods* and tracks their price on a regular basis.

CPI jumps around somewhat, and it can be distorted by the movements of specific goods in response to global events. These can have short-term influences over CPI, which the ABS tends to smooth out of the index. There are methodological questions about what's in that 'basket'...

... as well as the extent to which it represents Australian households broadly. For its flaws, the CPI is our best indicator of how quickly prices are rising. CPI then needs to be assessed in relation to a few other things: most importantly wages growth.

Over recent decades, CPI and wages growth have been roughly on par, meaning the standard of living of your average working household hasn't changed all that much. Your wages have gone up a bit, so has the price of everything.

The Wage Price Index, which tracks wages (abs.gov.au/statistics/eco…) puts wages growth at 2.4% for the previous 12 months to Sept 30, 2021 - this is an improvement over the longer term trend for wages after a COVID-inspired slowdown.

The other reason we need to look at these two things together is that the RBA is tasked with keeping inflation within a band of 2-3%, and wages growth is one of the key indicators it looks at to determine whether or not it needs to intervene in the economy and 'cool it down'.

Economists and the RBA draw a direct relationship between unemployment levels in the economy, wages growth, and inflation (CPI). The theory goes that there is a level of unemployment below which wages will push upwards, and that will cause prices to rise (inflation).

And so the RBA, using the monetary policy level of interest rates, 'tinkers' with the economy to take pressure off wages (and other inputs to the manufacture of goods and services), which translates into more people unemployed.

So, what were today's CPI figures... For the 12 months ending December 31, 2021, prices in our 'basket' of goodies increased 3.5%. That has set off some alarm bells, and I'll get to why in a moment. The increase was driven by a few items that moved significantly...

When those few items are adjusted, inflation comes back within the target range, at 2.6 or 2.7%. [Worth noting that goods were up 4.3%; services were up just 2.3%.]

So, two things are going to happen in response to these figures. One is an almost reflex reaction from big business calling for calm on wages demands and pointing to the role of wages growth in driving up prices. (This isn't true, but it's a reflex they can't control.)

Expect calls in coming days from the Business Council of Australia and large corporations, their various lobby groups etc, for immigration to be lifted, working visa numbers raised and fast. (This despite 637,000 Australians remaining out of work.)

The second thing that's going to happen, though, is that everyone will begin to wonder whether those magically low interest rates are going to start rising. And then they'll look at the levels of household debt in Australia (fuelling those house prices)...

... and then they're going to start wondering whether we'll see a property market correction (the value of residential properties in Australia has increased around $2.6tn during the pandemic) and a sell-off could get ugly.

The flow-on effects could be widespread. Calls for government intervention to protect those profits using taxpayer money won't be far behind.

Today's CPI data is on the high side, but I'm loathe to draw long-term conclusions in the midst of our pandemic-induced economic volatility. Our financial markets rarely show the same restraint.